Questions about Budget 2016

New Zealand Centre for Political Research

The New Zealand Centre for Political Research is a web-based think tank that takes a research-based approach to public policy matters and encourages the free and open debate of political issues.

“New Zealand’s economic outlook is positive. Treasury is forecasting real GDP growth of around 2.9 per cent over the coming year, and 2.8 per cent on average over the five years to June 2020. Over 200,000 more people are in work now than three years ago, and another 170,000 new jobs are expected by 2020. Over that period, the unemployment rate is expected to drop to 4.6 per cent and the average wage is forecast to rise to $63,000 a year. Only a handful of developed economies enjoy such a positive outlook.”

– Minister of Finance Hon Bill English, Budget Speech 2016.

On the surface, National’s eighth Budget looks sensible. It shows a small surplus, a plan to reduce debt, an increase in spending to address the pressure on social services due to record migration, and on-going investment in infrastructure and innovation.

In particular, this year’s projected $668 million surplus is expected to grow to $2.5 billion next year, rising to $5 billion in 2019, and $6.7 billion in 2020.

These stronger cash surpluses will allow the Government to pay down debt, which is forecast to peak at 25.6 percent of Gross Domestic Product (GDP) next year, falling to 19.3 percent by 2020. At that stage, contributions to the New Zealand Superannuation Fund are expected to resume, two years earlier than previously forecast.

In 2013, Finance Minister Bill English explained that his long term goal was to lower government spending to 25 percent of GDP. Budget 2016 confirms that he is on track, with core Crown expenditure reducing from a peak of 34.1 percent in 2011, to 29.7 percent this year, and 28.3 percent by 2020.

This reduction in spending is being driven in part by Bill English’s commitment to improving the performance of the public sector, which, excluding transfers, makes up a quarter of the economy. By adopting an “investment approach”, funding is prioritised into those areas that will deliver the most effective returns. Using data around lifetime liability and the public sector’s ten key result areas, the Minister wants government services to become more measurable and efficient in the years ahead.

However, while the Budget shows that progress is being made in improving New Zealand’s overall economic outlook, some key indicators signal that the future is not all rosy.

In particular, Treasury’s projections show that while economic growth is forecast to strengthen from 2.6 percent this year, to peak at a respectable 3.2 percent in two years time – driven by strong population growth, low interest rates, and increases in exports and tourism – growth is then expected to decline by 2020 to 2.5 percent, which is even less than it is now.

Further, while net migration inflows are predicted to peak at 70,700 in the year to June, within two years the numbers are expected to fall back to the long-term level of around 12,000 per year, as the Australian economy improves and attracts New Zealanders back across the Tasman.

In their Budget documents, Treasury explains that since our population is rising at its fastest pace in over 40 years, to employ this growing population and maintain incomes, our economy needs to keep expanding. That means an improvement in ‘productivity’.

Broadly speaking, productivity is a measure of the output of workers. To raise a country’s productivity, more value needs to be generated for each hour that is worked. Since worker incomes are linked to productivity, the more productive a work force is the greater the capacity for wages to increase. That’s why productivity is the key driver of higher living standards and a better quality of life.

According to Treasury, New Zealand’s growth in labour productivity to 2020 is projected to average just one percent a year. This is below our historical average of 1.2 percent over the 20 years from 1995 to 2015. They explain that this is caused by our growth being driven mainly by firms in labour-intensive industries such as construction, retail, and tourism, which traditionally have relatively low levels of productivity.

This week’s NZCPR Guest Commentator Dr Don Brash, the former Governor of the Reserve Bank, has examined the Budget and picks up on this issue:

“Much more seriously, though not surprisingly given that this Budget was the Government’s eighth and big changes in policy don’t happen in a third term government, there was not the slightest attempt to deal with our very slow growth in per capita incomes. Yes, aggregate growth looks reasonable, but that is very largely the result of very strong growth in population, in turn the result of a high rate of net immigration, not an increase in productivity.  And it is increased productivity which ultimately drives increases in incomes.

“Brian Fallow pointed out in the New Zealand Herald on the day after the Budget was delivered that ‘last year economic output grew 2.3 per cent but that was almost entirely explained by a 2.1 per cent rise in hours worked.’  He noted that in the 1990s ‘labour productivity grew at a brisk average pace of 2.6 per cent a year.  Between 2000 and 2007 it fell to 1.3 per cent and since 2008 it has averaged 0.8 per cent.’  He went on to point out that this ‘feeble growth in productivity is off a low base by international standards.  In Australia, for example, they produce one-third more per person than we do, despite our working 8 per cent longer hours on average.’

“And of course that very slow growth in output per hour worked is the fundamental reason why, despite reasonable aggregate economic growth, our real incomes are growing very slowly, and the gap between incomes in New Zealand and those in Australia – which the Government claimed they wanted to close by 2025 – has barely changed over the last eight years.”

While the Government has been heralding the fact that for the first time since the early nineties the exodus of New Zealanders to Australia has been reversed, as tens of thousands of Kiwis return home, Treasury’s forecasts show that this situation is not expected to last.

So what is it that the Australian Government is doing that will cause that country to again become a magnet to entrepreneurial Kiwis?

Firstly, the major difference between our two countries is, of course, our levels of wealth. According to the OECD, in 2015 Australians enjoyed a GDP per capita of $65,300, which was 32 percent higher than New Zealand’s $49,400. That makes Australians almost a third richer than New Zealanders.

And secondly, part of the answer almost certainly lies in tax. Australia already has a tax advantage over New Zealand, with the latest figures from the Heritage Foundation finding that in 2016, Australians paid only 27.5 percent of GDP in tax, while New Zealanders paid 32.1 percent, giving our country a heavier tax burden than most of our trading partners.

In their recent budget, the Australian Government announced across-the-board tax cuts, to reduce both income tax and company tax. The tax threshold on middle-income earners was lifted, a levy on high income earners was dropped, small business taxes were cut to 27.5 percent, and company tax will be lowered to 25 percent over the next ten years.

Clearly, the Australian Government puts great faith in the incentive effects of lower taxes to encourage work, employment, investment, innovation, immigration, and savings.

While he was Leader of the Opposition, Prime Minister John Key, also promoted the incentive value of tax cuts:

“This is the message to New Zealanders: under National, tax cuts are a priority—under National, personal tax cuts are a priority. Most of all, our tax cuts will not just be about putting dollars into the pockets of hard-working New Zealanders. They will actually be about delivering the right incentives in the economy. Tax cuts let New Zealanders get ahead in their lives. They encourage New Zealanders to work hard, to get extra responsibilities, to save, and to get further education. We believe in tax cuts, we believe in the power of tax cuts, and we will deliver them.”

Once elected, however, that thinking changed, and planned tax cuts were deferred in favour of higher government spending.

National also went into the 2014 election promising tax cuts – and they were specific about the date: “Income taxes would begin to fall from April 2017”.

Last year’s Budget Policy Statement confirmed this intention, reiterating that the Government’s fiscal priorities include “Beginning to reduce income taxes from 2017 with a focus on low and middle-income earners”.

However, their rhetoric has again changed through the addition of a proviso in the 2016 Budget Policy statement: “If economic and fiscal conditions allow, beginning to reduce income taxes from Budget 2017”.

The Prime Minister has justified this by explaining that the money set aside from this budget to help fund next year’s tax cuts has instead been used for social spending. While high migration rates have undoubtedly put pressure on health and education in particular, there remains a nagging question about whether the extra funding needed could have been found through cuts to wasteful spending.

The problem for taxpayers is that while governments traditionally use their budgets to fund essential services, they also use them for political purposes, to secure vested interest support in an MMP environment – as the post-budget gloating by National’s coalition support partner, the Maori Party, demonstrated only too clearly.

At their behest, National has poured another $40 million into Whanau Ora, taking their funding up to $72 million a year – despite the Auditor General reporting last year that not only was a third of the money being eaten up by administration, but that the objectives were so vague that it was impossible to determine how well the funding was being spent.

In addition, another $34 million was given to support the Maori language, $10 million for Maori Television, $14 million for a Maori Housing Network, $14 million for a Maori Land Service, $4 million to commemorate the Maori Land Wars – including education-related activities for schools – and $1.9 million a year for kapa haka. This takes the total value of race-based funding in the Maori Development Vote to $295 million a year – a 70 percent increase since National became the Government and wanted to keep the Maori Party happy!

In a 2005 report about New Zealand, the OECD said, “Of course, no government can make productivity growth happen; the best it can do is to identify and remove obstacles to growth and provide an economic environment in which firms and individuals can flourish.”

That means the Government should be focussed on ensuring the business environment is conducive to growth, not only to encourage Kiwi firms to invest and expand, but also, to convince entrepreneurs arriving in New Zealand to stay and use their talents and skills to grow our economy, instead of leaving and boosting someone else’s.

As well as cutting red tape and bureaucracy, it also means the Government should be pushing ahead with the fundamental reform of the Resource Management Act to require Councils to weigh up the economic benefits of a project, as well as the environmental effects, when considering resource consent applications.

It also means they should be lowering taxes to send a strong signal that success and hard work are valued in New Zealand. However, rather than cutting taxes, Budget 2016 effectively raises them by removing the two-for-one subsidies in the Emissions Trading Scheme.

Ultimately, a country is only as successful as its people. While the economy is now going in the right direction, more needs to be done to lift productivity and boost growth, to ensure that those who have come to New Zealand with skills and ideas will want to stay. While lowering the country’s tax burden is not, of course, the only variable that contributes to a vibrant economy, it would nevertheless incentivise productivity and innovation, the benefits of which would flow through to all New Zealanders through rising living standards. Given that Treasury’s forecasts show that migration growth is expected to reverse within a year or two, there is no time to lose.

 

THIS WEEK’S POLL ASKS:

In general, what priority would you give tax cuts in Budget 2017 – a high priority, a medium priority, or a low priority? 

 

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